Are you considering purchasing a home? Buying a home affords you a ton of benefits. You can personalize the countertops and hardware, paint them to your liking, or install a professional home entertainment system. However, there are other advantages that many people forget about— financial ones.
If you previously rented, all of your money went to the landlord, and none of it was tax-deductible. If you're a homeowner, this changes. Several tax credits or deductions are available whether you buy a mobile home, townhouse, condominium, co-operative unit, or single-family home.
Furthermore, the tax credits you receive will be heavily influenced by your state, whether you are a first-time home buyer, and the use of the property. Continue reading to learn more about the various tax credits available to homebuyers in 2023, as well as what they signify for home buyers.
Tax Breaks When Buying A House For The First Time
Tax credits are a means for the government to reward taxpayers for acting in certain ways or completing specific tasks. When you file your tax return, they instantly reduce the amount of tax you owe.
If you owe $10,000 in federal taxes but receive a $1,000 tax credit, your tax payment will be reduced to $9,000. As a result, tax credits are a better deal than deductions, which allow you to lower your taxable income. Deductions lower your tax liability, but not as much as a credit for the same amount.
First-time homebuyer tax credits are federal income tax credits offered by the government to those who buy their first house.
First-Time Homebuyer Act 2021: Up To $15000 Tax Credit
In order to boost the housing market and reduce disparities between wealthy and less wealthy neighborhoods, President Biden is aiming to approve the First-Time Homebuyer Act of 2021. This new tax credit is intended to assist low and middle-income first-time homeowners in purchasing a home without taking on too much debt.
The First-Time Homebuyer Act of 2021 authorizes federal tax credits of up to $15,000 for first-time homebuyers. It applies to any home purchased after January 1, 2021, and there is currently no end date or cap in place.
It's worth noting that the First-Time Homebuyers Tax Credit is still a bill, not a law. Before it may be used, it must pass both chambers of Congress. This tax benefit is still not available to first-time home buyers as of June 2022.
Who Is Considered a First-time Homebuyer?
Even those who have previously owned a house may be eligible for first-time homebuyer aid, according to the US Department of Housing and Urban Development's (HUD) criteria. A first-time homebuyer is defined as someone who meets any of the following criteria:
* A person who has not owned a primary residence for the previous three years as of the date they purchase the new property. A spouse is included in this (if either meets the above test, they are considered first-time homebuyers).
* A single parent who has only ever shared a home with a past spouse. If you're a single parent who recently purchased a property with your ex-spouse, you might qualify as a first-time purchaser.
* An individual who has only owned with a spouse and is a displaced housewife. For instance, if you supplied unpaid household services to family members for numerous years and just shared a home with your husband.
* An individual who has only owned a primary dwelling that is not properly affixed to a permanent foundation as required by law. This could indicate that you lived in a mobile house or another structure without a fixed foundation.
* A person who has only held a property that did not meet state, local, or model building codes and could not be brought into compliance for less than the cost of erecting a permanent structure.
When looking to take advantage of first-time home buyer assistance and tax credits, it's always good to inquire about how they define a 'first-time homebuyer' to see if you meet the requirements.
1. Mortgage Interest Credit
For low-income homeowners who received a qualified Mortgage Credit Certificate (MCC) from a state or local government to buy a primary residence, there is also a mortgage interest tax credit available in addition to the mortgage interest deduction.
In Texas, for example, the Texas State Affordable Housing Corporation offers mortgage tax certificates that let you deduct a large portion of your mortgage interest on your annual federal tax return.
The credit amount ranges from 10% to 50% of the annualized mortgage interest paid. (The precise proportion is shown on the MCC that was given to you). If the credit rate exceeds 20%, the credit is restricted to $2,000 only. The unused portion of the credit can be carried over to the following three years or until it is used, whichever comes first, if the limit reduces your total amount of permitted credit.
Let’s say you owe $10,000 in mortgage interest for 2023 and your state HFA issues you a 20% mortgage credit certificate. You will get a credit for 20% of $10,000, or $2,000, on your 2023 tax return. You can then include the remaining $8,000 of interest in your itemized deductions if it benefits you to itemize rather than take the standard deduction.
You will need a new MCC if you refinance your previous loan in order to be eligible for the credit on the new loan, and the credit amount may change. Additionally, you can be required to pay back all or part of the benefit you received from the MCC program if you sell the house before nine years have passed.
2. Roth IRA
If you qualify as a first-time homeowner, you can withdraw up to $10,000 from your traditional IRA and use the funds to buy, build, or rebuild a home. To utilize money from your IRA to buy a property, you must be a first-time homebuyer, but the IRS defines that status very broadly. You are considered a first-time buyer if you (and your spouse, if you have one) have not owned a property in the previous two years.
Even though you'll escape the 10% early withdrawal penalty, you'll still owe income tax on whatever amount you (and your spouse) take. Also, the $10,000 is a lifetime maximum. Even if you use a different IRA, you won't be able to use the first-time homebuyer provision again.
Tax Credits And Deductions For All Homebuyers
If itemizing deductions on your 2022 tax return makes financial sense, you can receive some federal tax savings for buying a house. Here are the tax incentives and deductions available to homeowners (both first and seasoned homebuyers).
1. Mortgage Interest Deduction
You can deduct the interest you pay on your mortgage to buy, build, or improve your primary home or second home thanks to the mortgage interest deduction, one of the biggest tax advantages for homeowners.
If you are a single taxpayer or a married couple filing jointly, you may deduct the interest paid on up to $750,000 of mortgage debt. The maximum for married couples filing separately is $375,000.
The mortgage interest deduction cap is $1 million for single filers, married couples filing jointly, and married couples filing separately if you purchased your house on or before December 15, 2017, and it is $500,000 if you did so after.
The interest paid on home equity loans and home equity lines of credit is subject to the same deduction restrictions (HELOCs). You can deduct the whole amount of interest paid on both loans if they were both used to build, buy, or improve your primary or secondary property if you're a single taxpayer and the total of your first mortgage and HELOC is less than $750,000, for instance.
2. Mortgage Points Deduction
When you obtain a mortgage, you typically need to pay "points" to the lender. Most of the time, the points you pay on a loan to buy, develop, or significantly improve your primary house are fully deductible in the year you pay them.
There are some conditions that must be met, such as the loan being secured by your primary residence, but generally speaking, you don't have to wait to deduct points paid for a typical mortgage.
You cannot deduct the loan points in the year that you pay them if you are purchasing a second house. However, you are still allowed to deduct them progressively over the course of the loan. If the loan has a 30-year term, you can subtract 1/30th of the points annually. For every $1,000 in points you purchased, that works out to $33 every year; it may not seem like much, but save it.
There is one more caveat, and it pertains to both subtracting points in the year you paid them and over the course of the loan. To be eligible for the deduction, you must itemize. (Most people choose the standard deduction over itemizing). Itemizers must enter deductible points on either line 8a or 8c of Schedule A for 2021 returns (Form 1040).
3. Mortgage Insurance Premium Deduction
Homeowners who paid private mortgage insurance for loans made after 2006 in the past year can write off their premiums for that year’s tax returns if they itemize. (PMI is often levied if you put less than 20% down when you purchase a property).
If your adjusted gross income (AGI) is over $100,000, the deduction phases out and eliminates if it is over $109,000 ($50,000 and $54,500, respectively, if you're married but file a separate return).
The amount of premiums you paid throughout the year is listed in Box 5 on the Form 1098 you get from your lender. The deductible amount should be reported on line 8d of your 2021 Schedule A. (Form 1040).
Here's the bad news, though. The 2021 tax year saw the termination of this deduction. However, in the past, the deduction has a history of expiring and then being reinstated, so it might be renewed for 2022 and beyond.
4. Home Office Deduction
You cannot claim the home office deduction if you work from home as an employee. Only those who regularly and solely utilize a portion of their house as their main place of business, including self-employed individuals, are eligible for the deduction.
Below are two main exceptions:
* If your house serves as your only place of business, you can deduct the cost of using a portion of it to keep inventory or samples without having to prove that the space is regularly and exclusively used for that purpose.
* Even if it's not your principal place of business, you can deduct costs related to a different building on your property that you use frequently and solely for your business.
What kind of domestic expenses can you claim with the home office deduction? The most typical are as follows:
* Real estate taxes
* Mortgage interest
* Mortgage insurance premiums
* Security systems
The home office deduction presents significant chances for tax savings, particularly in light of the increased standard deductions enacted by the Trump administration that may prevent you from realizing the benefits of itemizing your property taxes, mortgage interest, and mortgage insurance payments.
To properly claim this tax credit, you must strictly abide by a number of regulations. You cannot claim the same deductions on Schedule A and for your home office, for example, in order to avoid paying taxes twice. These alterations will be made automatically by any effective tax software.
5. Medically Necessary Home Improvements
If you install special equipment or modify your house for medical reasons, you can be eligible for a medical expense deduction. Adding ramps, enlarging entrances, putting handrails, lowering cupboards, repositioning electrical outlets, constructing lifts or elevators, altering doorknobs, and leveling the ground to give access to the residence are a few examples of medically essential home improvements.
If the update itself is medically required, costs for maintenance and operation of the upgrades are also deductible as medical expenses. However, if they aren't medically required, home modifications that merely make it easier for seniors to live in their homes (such as "aging-in-place" upgrades) aren't tax-deductible.
To take the deduction, you must itemize on Schedule A (Form 1040), and you can only write off medical costs that are greater than 7.5 percent of your adjusted gross income. Any increase in the value of your property also lowers the deduction. Therefore, if you install an elevator for $50,000 and it enhances the value of your home by $40,000, you can only deduct $10,000 ($50,000 – $40,000).
6. Property Tax Deduction
You are subject to numerous taxes, not simply income taxes. Your local real property tax is one of the extra taxes you'll have to get used to paying when you buy a house. The good news is that your state and local property taxes can be deductible on your federal income tax return.
However, there are a few kinks that could jeopardize this conclusion. To deduct real property taxes, you must first itemize. For the 2023 tax year, you may deduct them on line 5b of Schedule A if you choose to itemize (Form 1040).
Additionally, the total amount of state and local income, sales, and property taxes you can write off is limited to $10,000 ($5,000 if you're married but filing a separate return). Anything costing more than $10,000 is not deductible. Homeowners are particularly hard-hit by this in states with high income, sales, or property taxes.
7. Home Sale Exclusion
Due to the home sale exclusion, you probably won't have to pay taxes on the majority of the profit you might generate when you sell your property. You won't have to pay taxes on the first $250,000 of earnings if you owned and occupied the residence for at least two of the five years prior to the sale (i.e., capital gain).
If you're married and filing jointly, the amount doubles to $500,000. However, both couples must satisfy the residency criterion, and at least one spouse must meet the ownership requirement (i.e., lived in the home for two out of the previous five years).
If you have to sell your house early due to a divorce, a work shift, or another circumstance, you might be able to satisfy some of the residency requirements.
Any gains will be taxed at either the short-term capital gains rate or the long-term capital gains rate depending on how long you held the home:
* If you held the house for less than a year, short-term capital gains tax rates are applicable. Your ordinary income tax rate, which ranges from 10% to 37% for 2021 and 2022, will be applied to these gains.
* If you held the house for more than a year, long-term capital gains tax rates are applicable. Depending on your filing status and income, the rate is 0 percent, 15 percent, or 20 percent.
8. Increased Basis When Selling Your Home
You can still lower the amount of tax you owe by modifying the basis of your house if the capital gain exclusion does not totally eliminate your tax liability when you sell it. Your home's sales price less its basis will give you a taxed gain. Therefore, the lower the tax, the greater the basis.
The basis includes the price you originally paid for the house, which is a good thing! But you can also add on a variety of expenses related to buying and making improvements to your house.
You may, for instance, add certain settlement expenses and closing expenditures you incurred when purchasing the home. The basis includes the cost of the land, architect and contractor fees, construction permit costs, utility connection fees, and any associated legal costs if the house was built on land that you owned. You can also include the cost of major house improvements and additions in the base (but not basic repair and maintenance costs).
The Bottom Line
There are many tax advantages to buying a home. In order to maximize the value of your property during tax season, it's helpful to be a homeowner. It makes sense to total up your tax benefits because there could be thousands of dollars in potential tax deductions. Before choosing which option is best for your tax return, compare the total of your itemized deductions to the standard deduction.
You should spend some time looking into your tax deductions if you are buying a house. A tax expert should be consulted if you need assistance with the specifics of your situation to make sure you are taking full advantage of all the tax breaks that are available to you.
Thinking of purchasing a home in Texas? Why don’t you search for your next home with BHGRE HomeCity and take advantage of home buyer tax credits? Feel free to reach out to our qualified and experienced real estate agents for proper assistance regarding your home buying and selling needs.